19 April 2022
By Anna Macdonald
Equity markets began to arrest their first quarter falls during March. Extraordinary volatility continued in commodity markets. There were 10 trading days in March when Brent Crude rose or fell more than 5%. The volatility of UK 10-year gilts – a traditional safe haven – is now in double digits (12%) compared to 2% historically (source: Liberum).
Ukraine, Russia and Belarus each play significant roles in supplying energy and commodities to Europe in particular. Natural gas prices to Europe and the UK remain more than four times the levels of a year ago. Businesses and households are already struggling to adapt. Nearly three quarters of global potash – needed for fertiliser for crops and animal feed - comes from Belarus and Russia. These shortages have not yet hit farmers but are imminent. Wheat, rye, sunflower seeds, and rapeseed are critical soft commodities harvested in abundance in Ukraine and Russia, with supply constraints and price rises posing inflationary challenges to developing economies in particular. The war in Ukraine is an extraordinary human tragedy, and the evidence of Russian war crimes and extreme brutality makes any peaceful settlement currently seem very unlikely.
Highly valued equities have looked vulnerable as investors fret about expected interest rate rises to contend with inflation that is becoming more entrenched by the day. Companies at the lower end of the valuation spectrum have their own pressures, as they are often lower margin, capital or people intensive, and face rising input costs, wages and power prices.
It therefore feels like the path of safe investment opportunities is narrowing and we remain focused primarily on high quality businesses with robust profit margins and strong balance sheets.
The TB Amati Smaller Companies Fund returned 1.5% over the month, outperforming the Numis Smaller Companies Index (plus AIM, ex Investment Companies) benchmark by 0.9%.
Two of our principal contributors to performance were both bid situations. Caretech confirmed news reports that management were considering taking the company private. Brookfield Asset Management also announced that one of its infrastructure funds was in the preliminary stages of putting together a bid for Homeserve. Both stocks rose on the announcements.
Energy stocks such as Serica Energy and Energean continued their upward moves, backed by ever higher gas and oil prices. OSB Group had good numbers and investor enthusiasm grew for this midcap specialist lender delivering good growth, with a rock-solid balance sheet and low valuation multiple. Further capital returns seem likely.
Cake Box rose over 38% this month, recovering some of the losses seen at the beginning of the year. The market liked the new board and management appointments, and a trading update reassured investors that sales remained strong.
Essensys fell heavily on a trading update that revealed there had been delays to deals with landlords owing to Omicron shutting offices in the fourth quarter of 2021. The company is loss-making and whilst it has plenty of cash on the balance sheet, investor appetite has worn thin on IPOs. We visited management in their offices and felt comforted that the delays were indeed short term in nature. S4 Capital shocked the market on the penultimate day of the quarter when it announced that there had been a second delay to its results announcement. The first delay had been caused by its auditor PWC having to shut down its Dutch office during a Covid outbreak. This had not unduly concerned the market. The second delay received short shrift because the management team was not able to announce a particular reason for the exact issues that had led PWC to request more time to complete its audit. Shares fell more than 40%.
We have been continuing to shape the portfolio to seek less economically dependent shares such as Craneware and Indivior and to reduce exposure to cyclical stocks which may be hurt by a slowdown. Mindful of an increasing discount rate, we continue to take profits in some of our more expensively rated holdings.